Taxing times ahead if short-term capital gains treated as income

Savings are crucial for financing the investments that drive economic growth, and the South African government is committed to increasing the national savings rate. A key component of how individuals save is using unit trusts known in regulation as Collective Investment Schemes (CIS). The tax authorities in South Africa are exploring changes to the way such schemes are taxed.

In response to these proposed changes, South Africa’s leading CIS provider commissioned Genesis to assess the impact of the changes on the attractiveness of the industry’s products to domestic savers.

A key aspect of this analysis was understanding the taxation of short-term capital gains. In South Africa, these gains – that is, profits from the sale of assets held for one year or less – are taxed as ordinary income. By treating the profits from frequent trading by CIS as income rather than capital gains, these profits would be subject to income tax rates, which can be higher than capital gains tax rates.

Genesis’ analysis involved several steps. First, we compared the way CIS are taxed in countries such as the United Kingdom, United States, Brazil and Australia. Next we developed an informed perspective on how potential consequences of government policy might affect individuals’ choice of savings instruments. 

This was done by surveying 31 investment adviser companies, who are collectively responsible for a total AUM (assets under management) of R700 billion. Finally, we considered whether these changes might lead to a capital outflow from South Africa, given the availability of alternative products from offshore CIS providers.

Our analysis showed that the proposed changes to the regulation would undermine the very principles of the industry, and the reason why individuals use CIS products. These principles emphasise the freedom of fund managers to make strategic investment decisions, including buying and selling instruments, with the aim of optimising portfolio returns and facilitating long-term savings for investors. Taxing these transactions in other countries resulted in investors switching to products less suited to the achievement of long-term savings goals.

We also demonstrated that the proposed tax changes would diminish the appeal of local investments when compared to foreign investments in the jurisdictions most favoured by South African investors. This would contribute to capital flight , with funds leaving South Africa unlikely to return. This outcome would undermine the government’s overall policy position of promoting domestic savings.